Cost Segregation Studies
An engineering analysis that identifies parts of your building qualifying for large first-year deductions instead of being spread over 39 years — conducted in-house, integrated directly with your tax return.
When you buy a commercial building, the IRS requires you to depreciate the entire structure over 39 years. That means a $2 million building gives you a tax deduction of roughly $51,000 per year. Not terrible — but spread over nearly four decades, you are waiting a very long time to get the full tax benefit of your purchase.
A cost segregation study changes this by finding the parts of your building that the tax code allows you to depreciate much faster — in 5, 7, or 15 years instead of 39. And under current law (100% bonus depreciation is now permanent), anything with a depreciation life of 20 years or less can be fully deducted in the very first year you own it.
The result: instead of a $51,000 deduction the year you buy a $2 million building, you could have a $200,000 to $300,000+ deduction in Year 1. That is real money back in your pocket the same year you make the purchase.
The study is an engineering analysis of your building. An engineer reviews the construction documents, architectural plans, and the physical property itself to identify every component and determine which depreciation category it belongs in.
The IRS treats the structural shell of a building — the walls, foundation, roof — as 39-year property. But many components inside and around the building do not qualify as the structural shell. These are the components a cost segregation study finds and reclassifies:
5-year property: Specialty flooring (carpet, tile in non-structural applications), decorative light fixtures, removable partitions, certain plumbing fixtures for tenant use, security systems, and IT infrastructure.
7-year property: Office furniture built into the space, certain specialized equipment attached to the building for specific business use.
15-year property: Parking lots, sidewalks, landscaping, exterior lighting, fencing, land improvements — everything outside the building footprint that is not land itself.
Everything identified in these three categories is removed from the 39-year bucket and placed into the faster-depreciating buckets. With 100% bonus depreciation, all of it is deducted in Year 1.
Most CPA firms outsource cost segregation studies to third-party engineering firms. The client pays $5,000 to $15,000 for the study, waits 4 to 8 weeks for the results, and then the CPA must manually integrate a report they did not create into a tax return they are preparing. There is generally a risk of disconnect — a component reclassified in the study that does not translate correctly to the depreciation schedule on the return.
We conduct cost segregation studies in-house. The same team that prepares your tax return conducts the study. The findings go directly into Form 4562 with no third-party handoff, no translation risk, and no delay. For clients acquiring real estate, this eliminates $5,000 to $15,000 in third-party fees on every single acquisition — and produces a more defensible result because the study and the return are prepared by the same professionals.
- Large first-year deduction in the year of acquisition — instead of waiting 39 years to fully deduct the building, you pull a significant portion of that deduction into Year 1.
- 100% bonus depreciation on all reclassified components is now permanent law — there is no phase-down schedule to worry about and no urgency to accelerate acquisitions before a deadline.
- Improved cash flow: the tax savings in Year 1 are real cash you keep — which can fund the next acquisition, reduce debt, or be reinvested.
- Lookback studies available: if you purchased a property in prior years without a cost segregation study, we can catch up all the missed accelerated depreciation in the current year on a single return without amending prior returns.
- Works for any commercial property type — office, retail, industrial, medical, hospitality, residential rental — the only variation is how much of the basis qualifies for reclassification.
- Depreciation recapture at sale: when you eventually sell the property, the accelerated depreciation you took is "recaptured" and taxed at 25% federal rate (the Section 1250 unrecaptured gain rate). You are not eliminating tax — you are deferring it, often by many years, and sometimes into a lower-bracket year.
- Passive activity rules: if you are not a real estate professional, the large first-year deductions are passive losses. They can only offset passive income from other rental properties — not your W-2 income or business income. They carry forward until you have passive income or sell the property.
- Real estate professional election changes this: if your spouse qualifies as a real estate professional (750+ hours in real property activities), the passive losses become non-passive and directly offset all household income — dramatically increasing the immediate value of the deduction.
- Basis reduction: every dollar of depreciation reduces your adjusted cost basis in the property. Lower basis means higher gain when you sell — which is why 1031 exchange planning is often paired with cost segregation on heavily depreciated properties.
Property identification and feasibility assessment
Before ordering a study, we confirm it makes economic sense. For very small acquisitions (under $500,000 in depreciable property), the benefit may not justify the effort. For anything above that — and certainly for commercial properties above $1 million — the study almost always pays for itself many times over in the first year. We estimate the likely reclassification range and the projected tax savings before committing to the study.
Shurek — done before any external cost is incurredDocument collection and site review
We collect the purchase agreement, settlement statement, architectural drawings, construction documents, and any available cost breakdowns from the contractor or developer. For existing properties, we conduct a physical inspection of the property. For new construction, we review the construction documentation in detail. This is the engineering foundation of the study — the more complete the documentation, the more defensible the result.
Shurek — in-house engineering analysis, no outsourcingComponent analysis and reclassification
Each component of the building is analyzed against IRS guidance — primarily the MACRS Asset Class lives, Revenue Procedure 87-56, and the IRS Cost Segregation Audit Technique Guide. Every reclassified component is documented with a description, the legal authority supporting its classification, and its allocated cost. This documentation is what makes the study defensible in an IRS examination.
Shurek — in-houseStudy report preparation
The formal cost segregation study report is prepared, listing every reclassified component, the supporting authority, and the resulting depreciation schedules by asset class. This report is retained in your file and is the primary support document if the IRS examines the depreciation deductions.
Shurek — in-house, integrated directly with your tax returnIntegration into your tax return
The study findings go directly into Form 4562, which is the depreciation schedule attached to your tax return. Every reclassified asset appears with its proper asset class, the bonus depreciation election is made, and the resulting deduction flows through to your taxable income. Because we prepare both the study and the return, there is no handoff, no translation error, and no risk of a component appearing on the study but not on the return.
Shurek — filed with your tax returnLookback study via Form 3115 (for existing properties)
If you already own a property and have been depreciating it straight-line for years, a lookback study recalculates what the depreciation should have been from the acquisition date forward. The "catch-up" adjustment — all the extra depreciation you missed in prior years — is claimed as a single deduction on this year's return via a Form 3115 change of accounting method. No amended returns required. The IRS explicitly permits this approach under Revenue Procedure 2015-13.
Shurek — Form 3115 filed with current year return| Form | Name | When Due | What It Does and Why It Matters |
|---|---|---|---|
| 1040 | Individual Income Tax Return | April 15 annually (extension to October 15) | The depreciation deductions from the cost segregation study flow to your personal return here — either directly on Schedule E (if real estate) or through a business entity K-1. This is the form where the tax savings from the study actually appear as reduced taxable income. Every year you own the property, Form 4562 is attached to this return showing continuing depreciation. Without a proper 1040 reflecting the study's findings, the benefit of all the engineering work is never realized. |
| 4562 | Depreciation and Amortization | Filed with your tax return annually | This is the primary form where all depreciation deductions are reported. Every component identified in the cost segregation study appears here with its asset class, placed-in-service date, basis, and the bonus depreciation election. This form is attached to your return every year you own the property — not just in the year of acquisition. |
| 4562 (Election Statement) | Bonus Depreciation Election or Opt-Out | Filed with the tax return in the year of acquisition | You can elect to take 100% bonus depreciation (the default) or elect out of bonus depreciation for a particular asset class. Most clients take it. The election is attached to Form 4562. If you opt out for any reason — for example, because you are in a net operating loss position and want to spread the deduction — this election documents that decision. |
| 3115 | Application for Change in Accounting Method | Filed with the tax return in the year of the lookback study | Used for lookback studies on existing properties. This form notifies the IRS that you are changing your depreciation method from straight-line to the accelerated method you should have been using from the start. The catch-up adjustment — all missed depreciation from prior years — appears as a single "Section 481(a) adjustment" deduction on this year's return. The IRS generally allows this without challenge when done correctly. |
| 8582 | Passive Activity Loss Limitations | Filed annually with your return if you are not a real estate professional | This form tracks passive losses from rental activities. If the cost segregation deductions create losses that exceed your passive income, this form calculates how much of the loss you can use currently vs. how much carries forward. When you eventually sell the property, all suspended passive losses are released and available to offset the gain. |
| 4797 | Sales of Business Property | Filed in the year you sell the property | When you sell, this form reports the sale and calculates depreciation recapture. The Section 1250 unrecaptured gain (all your prior depreciation deductions, to the extent of gain) is taxed at a maximum federal rate of 25%. This is not a surprise — it is the expected trade-off for taking accelerated deductions earlier. We model this at acquisition so you know exactly what the recapture picture will look like at sale. |
Cost segregation is one of the few strategies on our list that we handle entirely in-house with no outside professionals required. We conduct the engineering analysis, prepare the study report, elect bonus depreciation, integrate the findings into your Form 4562, and maintain the depreciation schedules on every future return for as long as you own the property.
For lookback studies, we prepare the Form 3115 and calculate the Section 481(a) catch-up adjustment. At sale, we calculate the recapture and report it on Form 4797. The entire lifecycle of the cost segregation strategy — from acquisition to disposition — is handled by our team.
The closing documents from the acquisition — the HUD-1 or ALTA settlement statement, the purchase agreement, and any land value allocation from the appraisal. If you have construction documents, architectural drawings, or contractor cost breakdowns, those improve the study's accuracy and defensibility. For existing properties, access to the property for a physical inspection.
That is it. You buy the property and send us the closing documents. We do the rest.
Cost segregation is not a one-time event — the study creates a multi-year depreciation schedule that must be reflected correctly on every return for as long as you own the property. Here is every date that matters.
Study Conducted — Immediate Action Required
We begin the cost segregation study the moment acquisition documents are available. The study must be coordinated with the first-year tax return. There is no mandatory deadline for when the study must be ordered, but delaying into the second year after acquisition means missing the first-year bonus depreciation window for that year's return.
Form 4562 — Full First-Year Deduction Claimed
The study findings are entered into Form 4562 on your tax return for the acquisition year. The bonus depreciation election is made. This is the highest-value return in the property's lifecycle — the large first-year deduction appears here. Filed with your business or personal return by the applicable deadline.
Annual Return with Form 4562
Every year you own the property, Form 4562 is filed with your return showing ongoing depreciation on the remaining 39-year basis. The first few years after acquisition also include depreciation on any 5- or 7-year components not fully expensed via bonus in year one. We maintain the depreciation schedules and update them annually.
Annual Tax Planning Review
We review your real estate portfolio in Q4 to assess whether any new acquisitions warrant a cost segregation study in the current year, whether any lookback studies on existing properties would be beneficial, and whether the passive activity position (carryforward vs. current year use) is being optimized across the portfolio.
Recapture Modeling
Before listing any property for sale, we model the depreciation recapture tax — 25% on all Section 1250 unrecaptured gain. This calculation determines the minimum acceptable sale price and informs whether a 1031 exchange, installment sale, or opportunity zone reinvestment makes more sense than an outright sale.
Form 4797 — Depreciation Recapture Reported
Filed in the year of sale. Reports the recaptured depreciation as ordinary income at 25% federal rate. Any suspended passive losses are released and available to offset the gain. If a 1031 exchange is used, the basis carryover is calculated and documented for the replacement property.